Analyze a Startup

How would you select an organizational form for a business? Think about this question as you read the following scenario.

Joe Jones has created a business plan for a new product. He is not certain whether to organize his business as a regular corporation or a sole proprietorship. The following are his forecasted partial financial statements for the first four years of operation of the new venture named Uncle Joe's.

Forecasted partial Income Statement:

Year 1

Year 2

Year 3

Year 4

Sales

$15,000

$18,000

$23,400

$44,460

Cost of goods sold

8,000

10,000

15,000

21,000

Gross profit

7,000

8,000

8,400

23,460

Operating expenses

3,000

4,500

4,900

12,000

Interest

800

1,800

2,100

4,100

Earnings before taxes

2,200

2,700

2,800

7,900

Taxes

?

?

?

?

Net Income

?

?

?

?

Forecasted Balance Sheet:

Year 1

Year 2

Year 3

Year 4

Cash and inventories

$30,000

$45,000

$67,500

$101,250

Building and equipment

25,000

32,500

42,250

54,925

Total assets

55,000

77,500

109,750

156,175

Corporate Income Tax Schedule:

Taxable Income

Marginal Tax Rate

$1-30,000

10%

30,001-100,000

18

100,001-400,000

23

400,001-5,000,000

30

Over 5,000,000

40

Personal Income Tax Schedule:

Taxable Income

Marginal Tax Rate

$1-5,000

8%

5,001-20,000

12

20,001-60,000

19

60,001-180,000

25

Over 180,000

33

Using the information on Uncle Joes' finances, answer the following questions:

Calculate the net income earned and the taxes that would have to be paid in each year if the new venture is formed as a corporation.

Calculate the net income earned and the taxes that would have to be paid in each year if the new venture is formed as a sole proprietorship.

Calculate the following ratios for each year and interpret them:

Return on assets

Net profit margin

Asset intensity

Joe's firm will need to acquire assets in order to support the projected revenue growth. How would you recommend Joe finance these assets?

Do you recommend that Joe form a corporation or a sole proprietorship? Justify your answer.